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Information Spillovers and Cross Monitoring between the Stock Market and Loan Market:

Evidence from Regulation SHO

Matthew T. Billett
Fangzhou Liu
and
Xuan Tian

Current Version: February, 2016

* Billett (mbillett@indiana.edu) and Liu (liufan@indiana.edu) are with Kelley School of Business at Indiana
University. Tian (tianx@indiana.edu) is with Kelley School of Business at Indiana University and PBC School of
Finance at Tsinghua University. We are grateful for the comments and suggestions from Gregory Udell. We remain
responsible for any errors and omissions.

Electronic copy available at: http://ssrn.com/abstract=2732784

Information Spillovers and Cross Monitoring between the Stock Market and Loan Market:
Evidence from Regulation SHO

Abstract
We explore information spillovers and cross monitoring between the stock and loan markets. To
break simultaneity between the stock and loan markets, we use a regulatory experiment,
Regulation SHO, that relaxes short selling constraints for a randomly selected sample of Russell3000 stocks, which directly affects information production and monitoring by short sellers in the
stock market but is exogenous to the loan market. We find that while firms without bank
monitors exhibit a significant decline in stock prices upon the announcement of SHO, firms with
bank monitors do not react. Further evidence shows that firms affected by SHO enjoy a 21 basis
point lower loan spread that increases to 36 basis points for bank-dependent firms. Regulation
SHO, however, does not appear to affect non-price loan terms such as loan maturity, amount,
collateral, and covenants. Overall, our evidence suggests bi-directional information spillovers
and cross monitoring between the stock and loan markets. The effects on loan markets are
consistent with a reduction in the information monopoly that banks possess over their borrowers.

Key words: short selling constraints; Regulation SHO; information spillover, cross monitoring,
information monopoly, bank loan
JEL number: G14, G18, G21,

Electronic copy available at: http://ssrn.com/abstract=2732784

1.

Introduction
The costs and benefits of short selling constraints are hotly debated in the regulatory

community and in the academic literature. The debate centers on the benefits of increased price
discovery and information production versus the potential costs of manipulation. Prior academic
work documents numerous effects of short selling constraints that include stock liquidity
improvements and enhanced price discovery and more informative stock prices. While the
effects for stockholders have been well established, less is known about how short selling
constraints influence other firm stakeholders. For example, other external stakeholders, like
debtholders, may also benefit from enhanced stock liquidity and stock price informativeness, and
they may also be affected by potential stock price manipulation.
We explore how short selling constraints on a firms stock affects the loan contracts it
receives from its banks. The cross-monitoring hypothesis suggests that firm stakeholders benefit
from the monitoring and information collection conducted by other stakeholders.1 We examine
the bi-directional implications of the cross-monitoring and information spillovers between the
stock market and the syndicated loan market to see how price discovery in the equity market
influences bank contracting terms and vice versa. We find that reductions in short-sale
constraints in the stock market lead to reductions in the cost of bank loans. Exploring the relation
in reverse, we find that price discovery in the stock market depends on whether a firm has a bank
relationship, presumably because the bank provides information and/or certification benefits to
the stock market. Taken together we document significant bi-directional cross-monitoring
benefits that suggest that reducing frictions in one market has spillover benefits that affect
claimants across markets.

Given that monitoring and information collection costs are born by the firm ex-ante, a firm will select its mix of
claims in order to minimize these costs (see Jensen and Meckling (1976) and Booth (1992)).
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To identify these effects our tests exploit an exogenous event, the adoption of Regulation
SHO. Short selling has been largely constrained in the U.S. historically. The uptick rule that was
established in 1935, for example, prohibits short sales when stock prices are declining, which
imposes a significant cost on short sellers. In July 2004, the Security and Exchange Commission
(SEC) announced Regulation SHO that removed the uptick rule restriction for a randomly
selected group of firms (pilot group), which is about one third of the Russell 3000 firms listed on
NYSE, NASDAQ, and AMEX. The other two thirds of the Russell 3000 firms consist of nonpilot group for which the uptick rule remained in effect. This sudden regulatory change provides
a quasi-laboratory setting that exogenously shifts a firms short sale constraints, but does not
directly affect the loan market. 2 Because the uptick rule was removed, Regulation SHO
effectively reduced the cost of short selling, which should entice informed traders and result in
improved price transparency.3 In addition, lower short selling constraints may reduce managerial
agency costs if short sellers can profit by uncovering managerial misdeeds.
Banks, as inside lenders, may also affect information production and managerial
discipline. Banks screen and monitor borrowers, which entails ongoing information production
and collection costs. If information produced in the stock market affects these costs, then we
would expect the adoption of Regulation SHO to potentially influence bank loan pricing and
terms in two ways. First, if banks have lower screening and monitoring costs due to information
spillovers from short sellers, then the savings may be passed on to borrowers via lower loan
spreads. Second, if reducing short selling constraints allows traders to better profit from negative
private information, then firm managers may have a lower incentive to engage in self-interested

SECs selection of pilot firms was mainly based on the concern with the equal representation of the three stock
exchanges in the list and the average trading volumes of these stocks. Hence, the pilot study did not aim to influence
firms borrowing activities, nor was initiated by any specific corporate events.
3
Indeed prior studies (e.g. Bris, Goetzmann and Zhu, 2007, Reed, 2007, Berber and Pagano, 2013) find that short
selling restrictions associate with less liquidity and less informative stock prices.
2
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policies. This reduced agency concern could benefit banks if such managerial actions are value
destructive.4 The reverse is also true. If banks provide information and monitoring benefits that
are valuable to shareholders, then relaxation of short-selling constraints will be less influential
for firms with bank relationships. In other words, if the banks reduce the likelihood that
managers engage in self-interested policies and provide certification of firm condition, then
short-sellers will have a lower probability of uncovering such misdeeds and will, ex-ante, engage
in less information production by would-be short sellers.
We begin our tests of the above conjectures by exploring whether the stock market
reaction to SHO depends on the firms bank relationship. Grullon, Michenaud and Weston (2015)
document significant declines in the stock prices of SHO affected firms around the revelation of
SHO participation. Part of this decline in prices is argued to be driven by anticipation that
negative information about the firm will be revealed. Given banks monitor firms, we expect such
anticipation to depend on the existence of a bank monitor. We indeed find that this is the case.
The average cumulative abnormal return (CAR) for a SHO participating firm with a bank
relationship is 0.01% while that for participating firms lacking a bank relationship is -3.10%, and
the two CARs are significantly different at the 1% level.
Given that smaller firms likely have a greater degree of asymmetric information, we
stratify the sample based on firm size. We find that both small and large firms experience
insignificant CARs when they have a bank relationship (and significant negative CARs
otherwise). We find similar results if we stratify the sample based on the availability and level of
credit ratings. These findings are consistent with the screening and monitoring services banks
provide and is consistent with the literature that argues these services have spillover benefits to

4
Alternatively, if managers are more likely to maximize the value of equity, then risk-shifting may be a greater
concern which would negatively affect banks.
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shareholders (James, 1987). While splitting by firm size and other firm characteristics alleviate
selection concerns about the types of firms that borrow from banks, such concerns cannot be
completely eliminated. So we next explore within the sample of bank borrowers to see whether
the terms of the loans are affected by the change in the information environment induced by
Regulation SHO.
We find evidence consistent with these information effects. Using a difference-indifference (DiD) design, we find that borrowers affected by SHO experience a 12.7% reduction
in their cost of loans (equivalent to 21 basis points).5 This difference increases to 21.6% (36 basis
points) for bank-dependent borrowers (i.e. borrowers that lack a bond credit rating). These
findings are consistent with two interpretations. First, SHO may increase short sellers incentive
to uncover information which could reduce the monitoring and information production costs of
lenders. A portion of the reduced costs could be passed on to borrowers in the form of lower loan
spreads. Second, banks with a pre-SHO relationship with the firm may already incurred
information and monitoring costs, limiting any direct spillover benefits from regulation SHO to
the incumbent bank. Other potential lenders to the firm, however, may face lower information
and monitoring costs post-SHO and competitive pressure could force incumbent banks to lower
loan spreads. In other words, regulation SHO could reduce the information monopoly of
incumbent banks (see, e.g., Rajan, 1992).
In an attempt to distinguish these two alternative interpretations, we explore the effect of
Regulation SHO on non-price terms of loan deals. Prior studies show that non-price terms, such

This is in contrast to Kecsks, Mansi, and Zhang (2013) who find that the cost of borrowing goes up around
regulation SHO. They show this effect is pronounced in corporate bonds. This is consistent with the monitoring and
information production of banks (as inside lenders) versus bonds (as outside arms-length lenders), see Diamond
(1991a) and Rajan (1992).
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as maturity, covenants, and collateralization may alleviate agency costs. 6 If Regulation SHO
alleviates agency concerns, the first interpretation of our earlier finding, then non-price loan
terms would likely adjust (particularly among incumbent banks). Specifically we would predict
that Regulation SHO would lead to reductions in the number and tightness of covenants, to
lengthening of maturity, and to the reduction in the use of collateral.
We find no effects of Regulation SHO. To the extent that these non-price loan terms are
designed to mitigate agency and information concerns, and assuming bank monitoring
effectively substitutes for any disciplinary effects from short selling, these no-results suggest the
influence of information and monitoring channel on managerial behavior appears negligible.
Moreover, we find non-price terms for incumbent banks are unchanged around SHO. Taken
together, the evidence suggests that our findings on the effect of Regulation SHO on loan spreads
is more likely due to the reduction in the information monopoly that banks possess over bankdependent borrowers.7
Our study makes a number of important contributions. First, we demonstrate that
financial market frictions in equity markets significantly impact other stakeholders contracting
in other markets. Specifically, bank loan terms are significantly affected by the financial market
frictions in the equity market. This suggests the benefits gained from reducing financial market
frictions are much larger than simply the influence on shareholders. A number of papers (e.g.,
see Holmstrm and Tirole, 1993; Pagano and Rell, 1998)) argue the information production

The theoretical work of Rajan and Winton (1995), Gorton and Kahn (2000), Grleanu and Zwiebel (2009), and
Elkamhi et. al. (2015) show how covenants can reduce agency problems. Similarly Diamond (1991b) and Sharpe
(1991) demonstrate the effectiveness of maturity, and collateral is a mechanism in Stulz and Johnson (1985) and
Rajan and Winton (1995).
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A contemporaneous study, Ho, Lin, and Lin (2016), also documents a reduction in loan spreads around Regulation
SHO and concludes Regulation SHO reduces information asymmetry between the firm and the bank. Our results on
non-price terms (e.g., maturity, covenants, and amounts) suggest this argument may not necessarily be the case. Our
results on the shareholder wealth effects of SHO announcements also suggest a bi-directional channel of loan to
equity markets and not just from equity to loan markets.
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associated with being a publicly traded firm will behoove other stakeholders. For example, firms
with public equity must adhere to disclosure requirements and may entice analyst coverage that
results in information that may be useful to creditors. We show that the microstructure of equity
trading also has a pronounced effect on loan terms.
We also speak to the literature that debates the effect of short selling constraints on asset
prices and the cost of capital (e.g., Miller, 1977; Chen, Hong, and Stein, 2002; Battalio and
Schultz, 2006; Diether, Lee, and Warner, 2009; Boehmer, Jones, and Zhang, 2008, 2013). We
show that while alleviating short sale constraints may increase the cost of equity, this will be
partially offset by a decrease in the cost of loans. Our paper also contributes to the literature that
explores the effect of short sellers on corporate investment and financing decisions (e.g.,
Gilchrist, Himmelberg, and Huberman, 2005; Grullon, Michenaud, and Weston, 2015; Massa,
Zhang, and Zhang, 2015).
We also add to the banking literature. Much work has been done on how banks, as
information producers with inside access to the firm better screen and monitor lenders. These
benefits behoove not only the bank, but other stakeholders as well. Our results show that bank
relationships provide a certification and monitoring benefit to shareholders. Most prior evidence
on this involves the announcement of a bank loan and the elicited response in the equity markets
(see James (1987), Billett, Flannery and Garfinkel (1995), and most recently Ross (2010)), which
involves the endogenous decision to obtain and announce a loan. Our results show such benefits
exist in a setting where this particular form of endogeneity is absent. Prior work also
demonstrates a dark side to banks. Rajan (1992) shows that when banks obtain private
information the resulting information monopoly allows banks to hold-up the firm by charging

higher loan spreads. Our results show that the information production in the equity market may
help alleviate the banks information monopoly.

2. Sample selection and summary statistics


2.1 Sample construction
We start with the Russell 3000 index in June 2004 when constructing the sample. The
SECs first pilot order issued on July 28, 2004 (Securities Exchange Act Release No. 50104)
describes in detail how the pilot and non-pilot stocks in the Regulation SHO program are chosen.
Following that description, we exclude stocks that are not listed on the NYSE, AMEX, or
NASDAQ NM, and we exclude stocks that go public or have spin-offs after April 30, 2004. Of
the remaining 2,952 stocks, we identify 986 pilot stocks according to the published list of the
SECs pilot order. The remaining 1,966 stocks comprise the initial non-pilot sample. We further
exclude financial, utilities, and non-U.S. firms from our sample. We then merge this sample with
CRSP daily stock returns and exclude stocks with missing price information, price smaller than 5
dollars or greater than 1,000 dollars. This procedure results in 1,539 stocks for the stock
announcement return tests, among which 527 are pilot stocks and 1,012 are non-pilot stocks.
We use Dealscan to construct our sample of bank loans for our DiD analysis. We require
that the firm has loans originated within 2 years before the approval of Regulation SHO (June 23,
2004) and within 2 years after the implementation of Regulation SHO (May 5, 2005). We also
require that firms have non-missing loan contract information in the Dealscan database and nonmissing Compustat financial information in the same sample period. We then match loan
contract information with the most recent fiscal quarter-end financial data before loan
originations. We drop loans whose primary purpose is debtor-in-possession, share repurchase, or
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Leveraged Buyouts (LBO). We conduct our loan contract analysis at the loan facility level for
loan spreads, collateral amount, and maturity. We conduct loan covenant analysis at the loan deal
level. Our final sample consists of 1,621 loan facilities from 410 firms for the facility-level
analysis.

2.2 Bank relationship variables


We construct several measures to capture firms bank relationships. Our primary variable,
BANKCUR, is an indicator that equals one if a firm has an outstanding U.S. commercial bank
relationship and zero otherwise. This definition follows Sufi (2009)s argument that domestic
banks, as informed lenders, provide effective certification and monitoring services to borrowers.
To measure relationship strength, we construct two variables STRONGAMT, that measures
dependence on the relationship bank and LONGREL that measures length of the relationship
Following Bharath, Dahiya, Saunders, and Srinivasan (2011), we first look into firms borrowing
history in the past 5 years prior to Regulation SHO. A firm is defined to have a relationship bank
if this bank has been a lead arranger or sole lender two or more different deals. Then, for each
firm-bank pair, we compute the percentage of amount borrowed from this particular bank to total
amount the firm has borrowed in the past 5 years. STRONGAMT is an indicator variable that
equals one if a firm has a relationship lender and it borrows more than two thirds of loans from
that lender and zero otherwise. The second variable, LONGREL, built on the bank relationship
duration measure in Ongena and Smith (2001), is an indicator variable that equals one if the time
gap between the first and last loans from the same lender is larger than the sample median and
zero otherwise.

Previous studies show that lenders reputation affects firm value through screening and
monitoring channels (e.g. Billett, Flannery, and Garfinkel, 1995; Ross, 2010). We construct two
measures on a lenders reputation following Ross (2010): the first measure, DOM, is an indicator
variable that equals one if a firm has borrowed from one of dominant banks--Citi, JP Morgan
Chase and Bank of America, and zero otherwise. The second variable, DOMAMT, is an
indicator variable that equals one if a firms most important relationship lender, by loan amount,
is a dominant bank and zero otherwise. Because most loans in Dealscan are syndicated loans, we
use the lead arranger in these cases. Taking account of bank mergers and information
aggregation within financial conglomerates, we aggregate financial institutions to their parent
companies and assign acquired firms to their acquirers at the effective date of the merger.
Acquiring financial firms inherit both previous lead arranger-participant relationships and
previous borrowing firm relationships of the acquired firm.

2.3. Loan contract variables


We draw our loan contract variables mainly from Dealscan. We use the variable, All-inSpread-Drawn, as a measure on loan spreads. We use facility amount scaled by borrowing firms
total assets to measure loan amount. Previous studies on debt contracts suggest that debt contract
terms are often jointly determined, and non-price terms are also affected when firms credit
quality changes (e.g. Graham, Li, and Qiu, 2008). Therefore, besides loan price terms, we
examine changes on non-price loan terms around Regulation SHO as well. We construct four
non-price loan terms. The first variable, Maturity, is the number of months between the start date
and the end date of a loan facility. The second variable, Collateral, is an indicator variable that
equals one if a loan is secured and zero otherwise. To further examine whether lenders
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monitoring incentives on borrowing firms change around Regulation SHO, we use the number of
financial covenants and covenant cushions (Denis and Wang, 2014) that is defined by the
percentage difference between the underlying covenant variable and its contractual limit. The
former variable captures the degree of restrictions on a firms management in a similar spirit to
the G-index on shareholder governance (Bradley and Roberts, 2004), and the latter captures the
tightness of loan covenants.

2.4. Summary statistics


Table 1 provides summary statistics of the variables. Panel A shows descriptive statistics
of loan characteristics including both price terms (spreads) and non-price terms (maturity, loan
mount, collateral, and covenants). We find that the loan characteristics and distribution of loan
types and purposes are similar to previous studies on bank loan contracting (e.g. Bharath, Dahiya,
Saunders, and Srinivasan, 2011). Note that our sample period, 2002-2007, is a period of credit
expansion with institutional funds flowing into syndicated loans (e.g. Ivashina and Sun, 2011), as
a result, loan spreads are declining for both pilot and non-pilot firms throughout our sample
period. However, our DiD analysis effectively remove this general time trend in loan yields.
Panel B reports the descriptive statistics of borrowing firm characteristics prior to a loan
origination. An average firm has book value assets of 5.2 billion, book leverage of 30.5%,
tangible asset ratio of 35.4%, ROA of 3.6%, covered by 13 analysts, and market-to-book ratio of
1.3. 67% of our sample firms have credit ratings. Panel C reports the summary statistics of stock
announcement returns around Regulation SHO. The average CAR around the regulation SHO
announcement date is -0.67% and the median CAR is -0.10%. Panel D reports the fraction of

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firms with specific lending relationships as defined in Section 2.1. In our sample, 52.2% of firms
have an outstanding bank relationship.

3. Empirical results
3.1. Bank monitors and CARs around SHO announcement
We first examine whether SHO participating firms abnormal stock reactions to the
announcement of Regulation SHO depends on the firms existing bank monitors. Grullon,
Michenaud, and Weston (2015) show significant declines in the stock prices of pilot firms
around the revelation of SHO participation, using the same setting as ours. They argue that part
of this decline in prices is driven by market anticipation that negative information about the firm
will be revealed. Given that banks screen and monitor their borrowers, we expect that stock price
declines caused by market anticipation will depend on the existence of a bank monitor.
Specifically, our conjecture is that stock prices will drop less for firms with existing bank
monitors. This is because banks should have already produced valuable information and
effectively monitored their borrowers, which is observed by equity market participants and
priced into their stocks.
We compare market-adjusted stock returns of pilot and non-pilot firms based on whether
the firms have existing bank monitors. We begin by conducting univariate tests on marketadjusted returns for pilot firms with an existing bank relationship, pilot firms without an existing
bank relationship, non-pilot firms with an existing bank relationship, and non-pilot firms without
an existing bank relationship to examine which subgroup of firms experiences significant
abnormal returns and compare average abnormal returns across subsamples. We report the
results in Table 2 Panel A. Pilot firms without an existing bank relationship experience a
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significant -3.10% CAR around the Regulation SHO announcement. Pilot firms with an existing
bank relationship, however, do not experience significant abnormal returns. This observation
suggests that the existence of a bank monitor helps SHO affected firms to offset the negative
announcement effect of Regulation SHO. As a comparison, we do not observe significant CARs
for non-pilot firms regardless of the existence of bank relationships. Row 3 of Panel A reports
the difference of CARs between pilot and non-pilot firms among subsamples. For firms with an
existing bank relationship, stock returns of pilot firms do not show a significant difference from
control firms. In contrast, pilot firms underperform non-pilot firms by -2.70% on average if they
do not have existing bank relationships. This observation is consistent with Grullon, Michenaud,
and Weston (2015).
In Table 2 Panel B, We re-examine the tests in a multivariate setting using the following
model:

, (1)

where i indexes firm. CAR is the 11-day market-adjusted abnormal stock return. The key variable
of interest is Pilot*BANKCUR, which is an indicator that equals one if the firm is in the pilot
group and has an existing loan with a domestic commercial bank and zero otherwise. Control is a
set of control variables that includes firm assets, market-to-book ratio, leverage, and institutional
ownership and 1-digit SIC industry fixed effects.
In column (1), we present the results without control variables, which is the regression
form of Panel A. In column (2), we present the regression results with control variables. The
coefficient estimates of

is positive and its magnitude is comparable to that of

, which on

average effectively eliminates pilot firms underperformance relative to non-pilot firms if pilot
firms have existing bank relationships. Overall, our results suggest that significant stock price
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declines upon the SHO announcement documented by Grullon, Michenaud, and Weston (2015)
are mainly driven by firms without existing bank relationship. For firms with information
produced by banks and are monitored intensively by banks, their stock prices do not react.
Our findings in Table 2 are consistent with the literature that argues screening and
monitoring by banks have spillover benefits to shareholders (e.g. James, 1987). One concern,
however, is that bank borrowers are less transparent and more susceptible to short-sellers
uncovering negative information. In other words, the different reactions to the SHO
announcement documented above may be driven by differences in firm characteristics rather
than bank monitors. To alleviate this concern, in Table 3, we further partition the sample by firm
size, the availability and level of credit ratings. If our results are not driven by self-selection of
firm borrowing, we should observe the differential reactions of firms with and without existing
bank monitors persistent regardless of the way we partition our sample. To test our conjecture,
we estimate equation (1) separately in subsamples partitioned by firm size, the availability and
level of credit ratings, and the strength of bank relationships.
In Panel A, we split the sample by firm size. We define a firm as a small firm if its total
assets fall in the bottom tercile of Russell 3000 Index firms and a large firm if its total assets are
in the top two tercile of Russell 3000 Index firms. Small firms are less transparent, while large
firms typically are covered by a larger number of financial analysts, have greater institutional
ownership, and are generally assumed to have less information asymmetry. We estimate equation
(1) separately for large firms and small firms. The coefficient estimates of

are negative and

significant in both subsamples, consistent with our earlier findings that, compared to non-pilot
firms, pilot firms without a bank monitor experience a significant drop in stock prices upon the
SHO announcement. We further show that the coefficient estimates of
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are not significantly

different across subsamples. The p-values of F-statistics that test the joint significance of

are quite large. Hence, we cannot reject the null hypothesis that pilot firms with bank monitors
do not experience stock price declines upon the SHO announcement. Regarding the coefficient
estimate of the interaction terms, both are positive and it is statistically significant in the
subsample of small firms. The difference in

across the subsamples, however, is not

statistically significant. Our findings suggest that the differential reactions of firms with and
without existing bank monitors persistent in both large and small firms.
In Panels B and C, we split the sample by the availability and level of bond credit ratings.
In Panels D and E, we split the sample based on the strength of a firms existing bank
relationships. In Panel F and G, we split the sample based on the reputation of a firms lenders.
In all panels, we find that the coefficient estimate of
differences in

are positive in all subsamples, and the

across subsamples are not statistically significant. The evidence suggests that

the differential reactions of firms with and without bank monitors remain the same regardless of
the way we partition the sample. Hence, our results are unlikely to be driven by a firms selfselection into firm borrowing but are likely to be driven by the screening and monitoring services
provided by an informed lender.

3.2. SHO and loan spreads


The cross-monitoring hypothesis suggests that banks benefit from the monitoring and
information collection conducted by other stakeholders, such as short sellers, and will reduce the
spreads they charge on their borrowers. This argument could be true because of two reasons.
First, if banks have lower screening and monitoring costs due to information spillovers from
short sellers, then these may be passed on to borrowers via lower loan spreads. Second, if
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reducing short selling constraints allows traders to better profit from negative private information,
then firm managers may have a lower incentive to engage in self-interested policies. This
reduced agency concern could benefit banks if such managerial actions destroy firm value. In
this subsection, we explore how Regulation SHO affects loan spreads in the DiD framework.
Before undertaking the DiD analysis, we first verify the premise that the assignment of
pilot and non-pilot firms from the Russell 3000 index was random. We compare borrow and loan
characteristics of pilot and non-pilot firms. Because our sample only includes firms that have
loan originations both before and after Regulation SHO, many firms that do not have loans are
excluded. We report the results in Table 4.
In the top panel, we compare borrow characteristics of the closest fiscal quarter end
before the Regulation SHO Pilot Program approval date. Borrow characteristics include firm
assets, leverage, Z-scores, tangibility, profitability, analyst coverage, current ratio, and marketto-book ratio. In the bottom panel, we compare loan characteristics of the most recent loan deals
that are initiated before the SHO approval date. Loan characteristics include loan spreads,
maturity, amount, collateral, the number and tightness of covenants. We do both a t-test for the
differences in means and the Wilcoxon z-test for the differences in medians. Neither mean nor
median of the differences is statistically significant, which suggests that both group of firms and
their loans exhibit similar characteristics before Regulation SHO.
Next, we check the satisfaction of the parallel trend assumption, a key identifying
assumption, of the DiD approach. The parallel trend assumption requires that, in the absence of
Regulation SHO, the observed DiD estimator is zero. Specifically, the assumption requires
similar pre-SHO trends in loan spreads for both pilot and non-pilot firms, but does not require
the level of loan spreads to be identical before Regulation SHO. This is because the distinctions
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are differenced out in the estimation. We check the satisfaction of the parallel trend assumption.
In Figure 1, we plot the dynamics of loan spreads of pilot and non-pilot firms two years before
and after Regulation SHO. It shows that loan spreads are trending closely in parallel for the two
groups in the two years leading up to the event.
After ensuring that we have a balanced sample of pilot and non-pilot firms and the
parallel trend assumption is not violated, we examine whether pilot firms loan spreads change
after the reduction in short-selling costs due to Regulation SHO. Following earlier studies, we
estimate the following model:
Ln

,,

,,

(2a)

where i indexes firm, t indexes year, and l indexes loan. Ln(Spreads) is the natural logarithm of
loan spreads. During is an indicator variable that equals one if the loans are originated after the
effective date of Regulation SHO (May 05, 2005) and zero otherwise. Control is a set of control
variables that includes firm characteristics (firm size, market-to-book, book leverage, tangibility,
profitability, and z-score) and loan characteristic (loan amount, collateral, maturity, performance
pricing, loan purpose, and loan types). We control for firm and year fixed effects in the
regressions. We cluster standard errors at the firm level to address possible correlations among
residuals within firms.
One potential concern of the above specification is that, although Regulation SHO
represents an exogenous shock to short selling cost, a reverse causality may still arise if firms
with different cost of private loans are associated with certain characteristics that determine their
inclusion of the pilot group. To address this concern, we follow Bertrand and Mullainathan (2003)
to examine the dynamics of loan spreads surrounding Regulation SHO. If reverse causality is

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present, we should observe changes in spreads of loans originated before Regulation SHO.
Specifically, we estimate the following model:
Ln

,,

,,

(2b)

where i indexes firm, t indexes year, and l indexes loan. Year2 is an indicator variable that equals
one if the loan is originated in two years after the effective date of Regulation SHO and zero
otherwise. Year1 is an indicator variable that equals one if the loan is originated in one year after
the effective date of Regulation SHO and zero otherwise. Year-1 is an indicator variable that
equals one if the loan is originated in one year before the announcement of Regulation SHO and
zero otherwise. If there does not exist reverse causality, we should observe significant coefficient
estimates of

and

but insignificant coefficient estimate of

. Similar to equation (2a), we

control for firm and year fixed effects and cluster standard errors at the firm level. We report the
results in Table 5.
Column (1) reports the results estimating equations (2a). The coefficient estimate of
is negative and significant at the 1% level. The magnitude of

suggests that pilot firms

experience a 12.7% reduction in loan spreads (equivalent to 21 basis points) surrounding


Regulation SHO compared to non-pilot firms. In column (2), we report the results estimating
equation (2b). We find negative and significant coefficient estimate of
insignificant coefficient estimate of

and

, but

. This non-result suggests that loan spreads do not reverse

cause Regulation SHO.


Next, we examine how this result varies with a firms information environment and bank
dependence. We use the availability of public bond credit ratings to capture a firms information
environment. Faulkender and Petersen (2006) show that having credit ratings is a proxy for a
17

firms access to public bond markets. Hence, firms that lack access to public bonds are more
likely to be bank-dependent and should be affected more by Regulation SHO. In columns (3) and
(5), we estimate equation (2a) separately for firms with and without credit ratings. The
coefficient estimates of
However, the magnitude of

are negative and significant at the 5% level in both regressions.


in column (5) where bank-dependent borrowers are examined is

larger. The difference in loan spreads increases to 21.6% (equivalent to 36 basis points) for bankdependent borrowers. In columns (4) and (6), we estimate equation (2b) separately for firms with
and without credit ratings. We find a similar result: the reduction in band loan spreads is more
pronounced for bank-dependent borrowers. At the bottom of the table, we report the statistics
that test the equality in the key variable coefficient estimates. It shows that the differences in the
effect of SHO on bank loans are significant between borrowers with and without credit ratings.
This cross-sectional test further strengthens our argument that improvements in information
collection and monitoring by short sellers from the stock markets benefit more for more opaque
and hence bank-dependent borrowers.

3.3 Robustness checks on loan spreads.


In this subsection, we undertake three robustness checks to ensure that the effect of
Regulation SHO on loan spreads are likely causal.
First, a common criticism of studies that use Regulation SHO is that it represents one
regulatory change that took place in 2004. Hence, unobservable shocks occurred prior to 2004 or
coincide with SHO could have driven both the inclusion in the pilot program and reductions in
loan spreads, which undermines the causal inference we draw from the experiment. Note that,
although this argument is unlikely because SEC picked pilot stocks based on the ranking of
18

Russell 3000 stocks trading volume on an exogenously given date, which is highly likely to be
random, we still perform a test to address this concern. Specifically, we do a placebo test by
artificially picking a pseudo-event year, 2001 (three years before the actual Regulation SHO
year), when we assume a regulatory shock reduced short selling constraints. We, however, keep
the true set of pilot and non-pilot firms identified by Regulation SHO. We estimate equations (3a)
and 3(b) with During, Year2, Year1, and Year-1 defined based on the pseudo-event year, and
report the results in Panel A of Table 6.
None of the coefficient estimates of key variables of interest is statistically significant in
the main regressions in columns (1) and (2). In columns (3) (6) in which we partition the
sample based on firms availability of credit ratings, we continue to observe no change in loan
spreads around an artificially chosen event year.
The second robustness test we do is to keep the true SHO event year but randomly assign
firms into pilot and non-pilot groups by simulation. Specifically, in each simulation, we draw a
random sample of 135 pilot firms from the pool of our sample firms in the event year (2004),
and then treat the rest of the pool (the remaining 275 firms) as non-pilot firms. We do the DiD
test by estimating equations (3a) and (3b) on this simulated sample and repeat this procedure
5,000 times. We then summarize the regression results from this bootstrapped sample, and report
the distribution (i.e., mean, standard deviation, 25th percentile, median, and 75th percentile) of the
DiD estimates, namely, the coefficient estimates on Pilot*During, Pilot*Year2, and Pilot*Year1,
as well as their corresponding t-statistics in Table 6 Panel B.
As one can observe, the mean DiD estimates based on this simulated sample are all close
to zero. In addition, the distribution of the t-statistics suggests that none of these DiD estimators

19

is statistically significant. Hence, we cannot reject the null hypothesis that the DiD estimators
obtained from this randomization test are zero.
The third robustness test takes the advantage of a unique feature of the SHO experiment,
the removal of the tick restriction for all stocks on August, 2007. Hence, non-pilot firms become
treatment firms because they experienced a reduction in short selling constraints while pilot
firms become controls firms because their short selling constraints remained the same. Therefore,
we carry out a DiD test for the reversal of the Regulation SHO experiment using the same set
of pilot and non-pilot firms. We focus on their loans originated within 2 years around August,
2007. Specifically, we estimate the following model:
Ln

,,

,,

(3)

where i indexes firm, t indexes year, and l indexes loan. Post is an indicator variable that equals
one if the loan is originated in two years after the repeal of Regulation SHO Pilot program and
zero otherwise. If the reduction in loan spreads is caused by the relaxation of short sale
constraints, we expect the non-pilot firms experience reductions in loan spreads and hence
observe a positive estimate of the DiD estimate
The coefficient estimates of

. We report the results in Panel C of Table 6.

are positive but statistically insignificant for the whole sample

and also subsamples both with and without credit ratings. These findings could be driven by
anticipation of the repeal of the Regulation SHO Pilot program. Boehmer, Jones, and Zhang
(2015) find that anticipation prior to the formal repeal of Regulation SHO caused spillover
effects from the treatment group (non-pilot firms) to the control group (pilot firms) which makes
the repeal less informative than the adoption of Regulation SHO.

20

3.4. SHO and non-price loan terms


We have so far shown that borrowers affected by SHO experience a significant reduction
in the cost of loans and this effect is stronger for bank-dependent borrowers. This finding is
consistent with two interpretations. First, if short sellers incentive to uncover information
reduces lenders monitoring and information production costs, then banks may pass on part of
the savings to borrowers via lower loan spreads. Second, the incumbent bank may not benefit
from regulation SHO given the bank already possesses inside information; however, other
potential lending banks learn more about the firm. In this case the information and monitoring
benefits produced by short sellers after SHO reduces the information monopoly that incumbent
banks possess over bank dependent borrowers (see, Rajan, 1992). This reduced information
monopoly power will in turn force incumbent banks to lower loan spreads offered to their
borrowers (or lose them to competitor banks).
To help distinguish these two alternative interpretations, we explore the effect of
Regulation SHO on non-price terms of loan deals. Previous literature shows that the interest rate
(loan spread) charged may not be sufficient to solve agency concerns and can lead to credit
rationing (see Stiglitz and Weiss (1981) and Williamson (1986)). Later studies show that nonprice terms, such as maturity, covenants, and collateralization can mitigate agency and
information problems between the borrower and lender. Rajan and Winton (1995), Gorton and
Kahn (2000), Grleanu and Zwiebel (2009), and Elkamhi et al. (2015) illustrate how covenants
can reduce agency costs by screening borrowers as well as by incentivizing borrowers behavior.
Diamond (1991b) and Sharpe (1991) show that reducing the maturity of debt can alleviate
agency problems). Last, Stulz and Johnson (1985) and Rajan and Winton (1995) show that
posting collateral can reduce agency problems between borrowers and lenders. If the regulation
21

SHO reduces lenders perceived agency concerns, then we would expect to see non-price loan
terms to adjust (particularly among incumbent banks, which we explore below). Specifically we
would predict that regulation SHO would lead to reductions in the number and tightness of
covenants, to lengthening of maturity, and to the reduction in the use of collateral.
Table 7 reports the results on non-price loan terms, loan maturity, collateral, amount
scaled by assets, the number and tightness of covenants, in the DiD framework. Specifically, we
estimate equations (2a) and (2b) with the dependent variable replaced with Ln(Maturity),
Collateral, Ln(Facility/Assets), Number of covenants, and Debt/EBITDA covenant cushion. None
of the coefficient estimates of key variables of interest is statistically significant, suggesting that
reductions in short selling costs due to Regulation SHO do not lead to looser non-price loan
terms. The non-result indicates that the influence of information collection and monitoring
activities by short sellers on managerial behavior is perceived to be negligible, which suggests
that short sellers in the equity markets likely to affect the bank loan market through the reduction
in information monopoly that banks possess over their borrowers.
Table 8 provides further evidence to check the information monopoly argument. We
conduct the DiD tests on loan spreads and non-price loan terms on the a sample of firms that
receive new loans from their incumbent banks after Regulation SHO. While we see pilot firms
experience a 9.6% reduction in loan spreads, there are not significant changes in their non-price
loan terms. These results suggest that incumbent banks do not benefit from the information
production and enhanced monitoring by short sellers. Instead, they are likely responding to
competitor banks reduced information and monitoring costs in order to retain their borrowers.

22

4. Conclusion
In this paper, we have explored information spillovers and cross monitoring between the
stock and loan markets. To break simultaneity between the stock and loan markets, we use a
regulatory experiment, Regulation SHO Pilot Program, that relaxes short selling constraints on a
randomly selected sample of Russell-3000 stocks, which directly affects information production
and monitoring by short sellers in the stock market but is exogenous to the loan market. We find
that while firms without bank monitors exhibit a significant decline in stock prices upon the
announcement of SHO, firms with bank monitors do not react. Further analysis shows that this
result is unlikely driven by firms self-select into borrowing. We also find evidence that firms
affected by SHO enjoy a 21 basis point lower loan spread and the reduction in loan spreads
increases to 36 basis points for bank-dependent firms. Regulation SHO, however, does not
appear to affect non-price loan terms such as loan maturity, amount, collateral, and covenants.
Overall, our evidence suggests that there are bi-directional information spillovers and cross
monitoring between the stock and loan markets, and they affect the loan markets mainly through
the reduction in information monopoly that banks possess over their borrowers.

23

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26

Table 1. Summary Statistics


Panel A shows summary statistics of loan characteristics for 1,621 loan facilities originated in the sample
period of DiD test. Debt/EBITDA covenant cushion measure is defined by percentage difference between
firms actual Debt/EBITDA ratio and its contractual limit (Denis and Wang, 2014). The sample is drawn
from non-financial, non-utility firms from June 2004 Russell 3000 Index and requires a firm to have
loans origination before the approval of SHO Pilot program (June 2004) and after the implementation
(May 2005). Firms are also required to be listed on NYSE, AMEX or NASDAQ through 2002 to 2007,
have non-missing loan contract information in Dealscan and non-missing financial information in
Compustat. Loans with primary purpose of Debtor-in-possession, share repurchase and LBO are excluded.
All continuous variables are winsorized at the 5th and 95th percentiles. Panel B shows borrower
characteristics from the most recent fiscal quarter end prior to loan origination. Panel C shows marketadjusted stock returns around the Regulation SHO announcement day. The event window is (-10, 1) (from
July 14 to July 29, 2004). Stocks with missing price information during the event window and stocks with
price smaller than 5 dollars or greater than 1000 dollars are dropped from the sample. Panel D shows
distribution of bank relationship characteristic in sample firms in Panel C. BANKCUR is an indicator on
whether a firm has an outstanding U.S. commercial bank relationship. STRONGAMT is an indicator on
whether a firm have a relationship lender and it borrows more than 2/3 loans from that lender, in terms of
loan amount; LONGREL is an indicator on whether the duration of borrowing relationship (the time gap
between the first and last loans from the same lender) is larger than the sample median. DOM is an
indicator on whether a firm has borrowed from one of the dominant banks--Citi, JP Morgan Chase and
Bank of America. DOMAMT is an indicator on whether a firm's most important relationship lender, by
number of loan amount, is a dominant bank. All borrowing relationships are referred to sole lenders or
lead arrangers in syndicated loans. All financial institutions are aggregated to its parent companies.
Acquired firms are aggregated to their acquirers at the effective date of the merger. Acquiring financial
firms inherit both previous lead arranger-participant relationships and previous borrowing firm
relationships of the acquired firm.

27

Panel A. Loan Characteristics


Variable Names

Mean

SD

Min

P25

Median

P75

Max

1,621
1,621
1,621
1,621
1,621
1,621
1,621
1,182

4.87
164.80
49.79
3.77
19.29
0.62
0.67
2.02

0.74
103.73
22.12
0.61
1.11
0.48
0.47
1.36

3.22
25
2
2.49
16.81
0
0
0

4.32
75
36
3.58
18.52
0
0
1

5.01
150
60
4.09
19.34
1
1
2

5.42
225
60
4.09
20.03
1
1
3

5.99
400
240
4.43
21.28
1
1
6

357

0.51

0.28

0.00

0.30

0.48

0.74

1.00

Loan Type Dist. (%)


Revolver>=1 year
Term loan
Revolver< 1 year
364-day facilities
Bridge loan
Other

1,621
1,621
1,621
1,621
1,621
1,621

57.87
27.51
1.36
9.81
1.23
2.22

Loan Purpose Dist. (%)


Corporate
Recapitalization
M&A
Back-up
Other

1,621
1,621
1,621
1,621
1,621

68.48
0.25
16.10
6.54
8.64

Min
5.49
0.02
0.16
0.04
0.01
1.22
0.60
0.65

P25
6.64
0.18
1.26
0.15
0.02
3.39
1.06
0.92

Median
7.63
0.30
2.38
0.30
0.03
6.27
1.47
1.21

P75
8.65
0.41
4.73
0.54
0.05
13.88
2.03
1.61

Max
10.04
0.62
23.78
0.84
0.08
76.60
3.44
2.72

Loan Terms
Ln(Spread)
Spread (bps)
Maturity in months
Ln(Maturity)
Ln(Facility amount in dollars)
Collateral
Performance pricing
Number of financial covenants
Debt/EBITDA covenant
cushion

Panel B. Borrower Characteristics Prior to Loan Origination


Variable Names
Ln(Assets)
Book Leverage
ZSCORE
Tangibility
Profitability
Coverage
Current Ratio
Market to Book
With Credit Rating (% of firms)

N
1,157
1,157
1,130
1,157
1,157
1,086
1,111
1,157

Mean
7.68
0.31
4.40
0.35
0.04
13.24
1.63
1.34

410

0.67

SD
1.29
0.16
5.62
0.24
0.02
18.11
0.75
0.55
28

Panel C. Regulation SHO Stock Announcement Returns


Variable Names
Daily Abnormal Return (in %)
CAR(-10,1), in %

N
18,468

Mean
-0.04

SD
2.89

Min
-50.83

P25
-1.17

Median
-0.06

1,539

-0.67

9.39

-56.93

-4.69

-0.10

SD
0.50
0.50
0.47
0.49
0.48

Min
0
0
0
0
0

P25
0
0
0
0
0

Median
1
1
0
0
0

P75
1.04

Max
73.11

3.51 172.78

Panel D. Lending Relationship Characteristics


Variable Names
BANKCUR
STRONGAMT
LONGREL
DOM
DOMAMT

N
1,539
1,539
1,539
1,539
1,539

Mean
0.52
0.50
0.32
0.41
0.34

29

P75
1
1
1
1
1

Max
1
1
1
1
1

Table 2. Regulation SHO Announcement Returns.


This table presents the effect of an outstanding bank lending relationship on pilot firms abnormal stock
reaction to Regulation SHO announcement documented in Grullon, Michenaud, and Weston (2015). The
dependent variable is 11-day market-adjusted return and event window is (-10, 1) around the Regulation
SHO announcement day (from July 14 to July 29, 2004). The sample is drawn from non-financial, nonutility U.S. firms from the June 2004 Russell 3000 Index and firms are required to be listed on NYSE,
AMEX or NASDAQ through 2002 to 2007 and have non-missing financial information in Compustat.
Stocks with missing price information during the event window and stocks with price smaller than 5
dollars or greater than 1,000 dollars are dropped from the sample. BANKCUR is an indicator on whether
a firm has an outstanding U.S. commercial bank relationship. All borrowing relationships are referred to
sole lenders or lead arrangers in syndicated loans. All financial institutions are aggregated to its parent
companies. Acquired firms are aggregated to their acquirers at the effective date of the merger. ***, **, *
indicate significance at the 1%, 5% and 10% levels using two-tailed tests.
Panel A. Univariate Test

Pilot
T- Stat
Obs
Control
T- Stat
Obs
Diff (Pilot-Control)
T- Stat
Obs

(1)
BANKCUR=1
0.01
(0.03)
279
-0.00
(-0.01)
525
0.01
(0.03)
804

30

(2)
BANKCUR=0
-3.10***
(-5.21)
248
-0.40
(-0.73)
487
-2.70***
(-3.35)
735

(3)
Diff. (1)-(2)
3.11***
(4.17)
527
0.40
(0.63)
1,012
2.71***
(2.79)
1,539

Panel B. Multivariate Test

Pilot
BANKCUR
Pilot*BANKCUR

(1)

(2)

-2.702***
(0.807)
0.395
(0.626)
2.717***
(0.974)

-2.475***
(0.820)
-0.745
(0.618)
2.619***
(0.996)
-1.782
(1.515)
0.176
(0.168)
-0.816***
(0.187)
1.331
(1.245)
-2.713
(3.535)
Yes
1,504
0.036

Book Leverage
Ln(Assets)
Market to Book
Institutional Ownership
Constant
Industry Fixed Effects
Observations
Adjusted R-squared

-0.400
(0.544)
No
1,539
0.012

31

Table 3. Regulation SHO Announcement Returns: Subsamples by Firm and Bank Relationship
Characteristics
This table presents the effect of an outstanding domestic bank relationship on the difference of Regulation
SHO cumulative announcement returns between pilot and control firms documented in Grullon,
Michenaud, and Weston (2015), controlling for a specific firm or bank relationship characteristic. We
divide the firms in Table 2 into two subsamples based on the characteristic under examination and run the

following regression for each subsample:


. Control variables include size, market to book ratio, book leverage,
institutional ownership and 1-digit SIC industry fixed effects. The event window is (-10,1) around the
Regulation SHO announcement day (from July 14 to July 29, 2004). The sample is drawn from nonfinancial, non-utility U.S. firms from the June 2004 Russell 3000 Index and firms are required to be listed
on NYSE, AMEX or NASDAQ through 2002 to 2007 and have non-missing financial information in
Compustat. Stocks with missing price information during the event window and stocks with price smaller
than 5 dollars are dropped from the sample. BANKCUR is an indicator on whether a firm has an
outstanding U.S. commercial bank relationship. STRONGAMT is an indicator on whether a firm have a
relationship lender and it borrows more than 2/3 loans from that lender, in terms of loan amount;
LONGREL is an indicator on whether the duration of borrowing relationship (the time gap between the
first and last loans from the same lender) is larger than the sample median. DOM is an indicator on
whether a firm has borrowed from one of the dominant banks--Citi, JP Morgan Chase and Bank of
America. DOMAMT is an indicator on whether a firm's most important relationship lender, by number of
loan amount, is a dominant bank. All borrowing relationship are referred to sole lenders or lead arrangers
in syndicated loans. All financial institutions are aggregated to its parent companies. Acquired firms are
aggregated to their acquirers at the effective date of the merger. Acquiring financial firms inherit both
previous lead arranger-participant relationships and previous borrowing firm relationships of the acquired
firm. P-values of regression coefficients (Pilot and Pilot*BANKCUR), F-test of join significance
(Pilot+Pilot*BANKCUR) and Wald test of coefficients across subsamples are shown in parentheses. ***,
**, * indicate significance at the 1%, 5% and 10% levels.
Panel A. By Size
Small

Obs
548

Pilot
-2.89**
(0.03)
-1.71*
(0.07)
-1.18
(0.47)

Pilot*BANKCUR
4.21*
(0.06)
1.65
(0.13)
2.56
(0.30)

Pilot+Pilot*BANKCUR
0.62
(0.43)
0.01
(0.92)

Big

956

Obs

Pilot

Pilot*BANKCUR

Pilot+Pilot*BANKCUR

With Credit Rating

650

-3.32***
(0.00)

3.22**
(0.01)

-0.10
(0.88)

Without Credit Rating

854

-2.17**
(0.04)

2.72*
(0.08)

0.55
(0.59)

-1.15
(0.45)

0.50
(0.80)

Diff (Small-Big)

Panel B. By Credit Rating Availability

Diff (With-Without)

32

Panel C. By Credit Ratings


Investment Grade

Obs
361

Speculative Grade

289

Diff (Investment-Speculative)

Pilot
-2.88**
(0.02)
-3.22*
(0.07)
0.34
(0.87)

Pilot*BANKCUR
3.10**
(0.03)
2.45
(0.26)
0.65
(0.79)

Pilot+Pilot*BANKCUR
0.22
(0.75)
-0.77
(0.54)

Pilot
-2.13**
(0.05)
-3.47***
(0.00)
1.34
(0.41)

Pilot*BANKCUR Pilot+Pilot*BANKCUR
2.42
0.29
(0.10)
(0.77)
3.55**
0.08
(0.01)
(0.90)
-1.13
(0.58)

Pilot
-2.88*
(0.06)
-2.45**
(0.11)
-0.43
(0.81)

Pilot*BANKCUR Pilot+Pilot*BANKCUR
2.64
-0.24
(0.13)
(0.73)
2.98**
0.53
(0.02)
(0.54)
-0.34
(0.87)

Pilot
-3.08**
(0.01)
-2.29**
(0.03)
0.79
(0.62)

Pilot*BANKCUR Pilot+Pilot*BANKCUR
2.88**
-0.20
(0.04)
(0.75)
2.64*
0.35
(0.08)
(0.73)
0.24
(0.91)

Panel D. By STRONGAMT
STRONGAMT=1

Obs
753

STRONGAMT=0

751

Diff (STRONGAMT=1STRONGAMT=0)

Panel E. By LONGREL
LONGREL=1

Obs
492

LONGREL=0

1,012

Diff(LONGREL=1LONGREL=0)

Panel F. By DOM
DOM=1

Obs
624

DOM=0

880

Diff (DOM=1-DOM=0)

33

Panel G. By DOMAMT
Obs

Pilot

DOMAMT=1

522

-2.94**
(0.03)

2.31
(0.13)

0.63
(0.39)

DOMAMT=0

982

-2.34**
(0.02)

2.95**
(0.03)

0.61
(0.47)

-0.60

-0.64

(0.72)

(0.75)

Diff (DOMAMT=1DOMAMT=0)

34

Pilot*BANKCUR Pilot+Pilot*BANKCUR

Table 4. DiD Diagnostics.


This table compares firm and loan characteristics of pilot and controls firms immediately before
Regulation SHO Pilot program. Definitions of variables can be found in Table 1 Panel A. Borrower
characteristics are from the closest fiscal quarter end before the Regulation SHO Pilot Program Approval
Date (June 23, 2004). Loan Characteristics are from the most recent loans that initiated before Regulation
SHO Approval Date.
Borrower Characteristics
Variable
Ln(assets)
Book Leverage
ZSCORE
Tangibility
Profitability
Coverage
Current Ratio
Market to Book
Loan Characteristics
Variable
Spread
Ln(Spread)
Maturity in months
Ln(Maturity)
Ln(Facility amount in dollars)
Facility amount/Total Assets
Collateral
Number of Financial Covenants
Debt/EBITDA Covenant
Cushion

Pilot
7.396
0.294
4.541
0.341
0.037
14.832
1.834
1.376

Control
7.547
0.299
4.497
0.341
0.035
17.242
1.733
1.433

Difference
-0.151
-0.005
0.044
0.000
0.002
-2.410
0.101
-0.057

T-stat
-1.045
-0.285
0.082
-0.017
1.196
-0.922
1.067
-0.918

Wilcoxon z- stat
-0.979
0.005
0.184
0.065
0.945
0.039
1.554
-1.140

Pilot
174.711
4.943
42.815
3.603
18.998
0.193
0.570
1.659

Control
172.131
4.946
41.978
5.587
19.129
0.202
0.553
1.171

Difference
2.580
-0.003
0.837
-1.984
-0.131
-0.009
0.017
0.488

T-stat
0.246
-0.043
0.392
0.260
-1.185
-0.429
0.337
-0.417

Wilcoxon z-stat
0.298
0.414
0.326
0.306
-1.090
0.983
0.338
-0.632

0.486

0.473

0.013

0.252

0.413

35

Table 5. DiD Tests on Loan Spreads


This table shows OLS regressions on Regulation SHO Pilot program's effect on loan spreads. The
dependent variable is Ln(Facility Spread). The sample is drawn from non-financial, non-utility firms
from June 2004 Russell 3000 Index and requires a firm to have loans origination before the approval of
SHO Pilot program (June 2004) and after the implementation (May 2005). Firms are also required to be
listed on NYSE, AMEX or NASDAQ through 2002 to 2007, have non-missing loan contract information
in Dealscan and non-missing financial information in Compustat. Loans with primary purpose of debtorin-possession, share repurchase and LBO are excluded. Test statistics and p-values of Wald tests on
equality of DiD estimators of subsamples by credit rating availability are shown at the bottom of the table.
Dependent variables are winsorized at 5th percentile. Standard errors clustered by firm are in parentheses.
***, **, * indicate significance at the 1%, 5% and 10% levels using two-tailed tests.
Whole Sample
(1)
Pilot*During

Pilot*Year1
Pilot*Year-1
Ln(Facility Amount)
Ln(Maturity)
Collateral
Performance Pricing
Ln(Assets)
Market to Book
Profitability
Book Leverage
Modified ZSCORE
Tangibility
Loan Purpose
Loan Type
Year FE
Firm FE

(2)

-0.127***
(0.043)

Pilot*Year2

-0.048***
(0.015)
-0.039
(0.038)
0.347***
(0.059)
-0.038
(0.025)
0.105**
(0.050)
-0.095***
(0.028)
0.614
(0.921)
0.589***
(0.144)
-0.136*
(0.071)
-0.214
(0.268)
Yes
Yes
Yes
Yes

With Credit Ratings


(3)
-0.106**
(0.048)

-0.159**
(0.080)
-0.115*
(0.069)
-0.006
(0.065)
-0.048***
(0.015)
-0.039
(0.038)
0.346***
(0.059)
-0.038
(0.025)
0.105**
(0.050)
-0.095***
(0.028)
0.647
(0.927)
0.584***
(0.144)
-0.137*
(0.071)
-0.223
(0.272)
Yes
Yes
Yes
Yes

-0.074
(0.079)
-0.130*
(0.073)
-0.007
(0.066)
-0.037**
-0.037**
(0.018)
(0.018)
-0.062
-0.060
(0.048)
(0.047)
0.416***
0.418***
(0.073)
(0.074)
-0.039
-0.038
(0.028)
(0.028)
0.091*
0.092*
(0.054)
(0.054)
-0.093**
-0.093**
(0.039)
(0.039)
0.020
0.004
(1.040)
(1.051)
0.669***
0.677***
(0.182)
(0.184)
-0.084
-0.084
(0.080)
(0.081)
0.010
0.011
(0.294)
(0.299)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
36

(4)

Without Credit Ratings


(5)

(6)

-0.216**
(0.087)

-0.076**
(0.029)
0.007
(0.062)
0.209**
(0.094)
-0.016
(0.054)
0.190*
(0.106)
-0.135***
(0.050)
1.616
(1.511)
0.391
(0.296)
-0.284**
(0.123)
-0.917
(0.606)
Yes
Yes
Yes
Yes

-0.451**
(0.177)
-0.154
(0.147)
-0.101
(0.151)
-0.080***
(0.029)
0.010
(0.059)
0.201**
(0.088)
0.003
(0.049)
0.172*
(0.103)
-0.129***
(0.048)
2.049
(1.550)
0.379
(0.287)
-0.289**
(0.120)
-1.036*
(0.588)
Yes
Yes
Yes
Yes
(Continued)

Table 5 continued
Whole Sample

Observations
Adjusted R-squared
Number of Firms

With Credit Ratings

(1)

(2)

(3)

1,621
0.532
410

1,621
0.532
410

1,177
0.548
274

Wald Test of Equality on Pilot*During across Subsamples:


Wald Test of Equality on Pilot*Year2 across Subsamples:
Wald Test of Equality on Pilot*Year1 across Subsamples:
Wald Test of Equality on Pilot*Year-1 across Subsamples:

37

(4)

Without Credit Ratings


(5)

(6)

1,177
0.548
274

444
0.520
136

444
0.531
136

1.27
4.00
0.02
0.34

P-value
P-value
P-value
P-value

0.26
0.05
0.88
0.56

Table 6. Robustness Tests on Loan Spreads


This table presents three robustness checks on the DiD tests in Table 3. Panel A took the original sample
firms and shows the effect when the Pilot program expired and all the firms were exempted from the
uptick price test. The Post period is defined from August 2007 to August 2009. Panel B is the placebo test
result on loan spread when we took the original sample firms and use June 2001 as a pseudo-event
announcement date and May 2002 as pseudo implementation year. Panel C reports results for
randomization tests based on 5000 simulated samples. For each simulation, we draw a random sample of
135 pilot firms from our original sample of 410 firms, and then treat the rest of the pool (275 of them)
as non-pilot firms. We then perform the DiD tests as in Table 2 on this simulated sample. We repeat the
simulation process 5000 times and summarize the distributions of the coefficients and t-stats for the main
variables of interest.
Panel A. Using 2001 as Pseudo Event Year
Whole Sample
(1)
(2)
Pilot*During

-0.045
(0.056)

Pilot*Year2

With Credit Rating


(3)
(4)
-0.069
(0.064)

-0.037
(0.095)
0.065
(0.097)
0.102
(0.098)

Pilot*Year1
Pilot*Year-1

0.104
(0.103)
-0.067
(0.108)
0.042
(0.109)
0.099
(0.112)

0.102
(0.139)
0.159
(0.162)
0.033
(0.174)

Loan Characteristics
Firm Characteristics
Loan Purpose
Loan type
Year FE
Firm FE

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Observations
Number of Firms
Adjusted R-squared

818
188
0.374

818
188
0.377

685
148
0.395

685
148
0.398

133
40
0.475

133
40
0.466

38

Without Credit Rating


(5)
(6)

Panel B. Randomization Tests Based on 5000 Simulated Samples


Mean
SD
Model (1) of Table 5
Coefficient of Pilot*During
0.0005
0.0453
T-stat for Pilot*During
0.0003
1.0394
Model (2) of Table 5
Coefficient of Pilot*Year 2
0.0008
0.0742
T-stat for Pilot*Year 2
0.0280
1.041
Model (2) of Table 5
Coefficient of Pilot*Year 1
0.0010
0.0729
1
T-stat for Pilot*Year
0.0004
1.0460
Model (3) of Table 5
Coefficient of Pilot*During
0.0000
0.0533
T-stat for Pilot*During
-0.0159
1.0442
Model (4) of Table 5
Coefficient of Pilot*Year 2
0.0009
0.0802
T-stat for Pilot*Year 2
0.0155
1.0535
Model (4) of Table 5
Coefficient of Pilot*Year 1
0.0010
0.0829
1
T-stat for Pilot*Year
-0.0126
1.0575
Model (5) of Table 5
Coefficient of Pilot*During
0.0016
0.0888
T-stat for Pilot*During
0.0300
1.0986
Model (6) of Table 5
Coefficient of Pilot*Year 2
0.0020
0.1719
2
T-stat for Pilot*Year
0.0717
1.1252
Model (6) of Table 5
Coefficient of Pilot*Year 1
0.0017
0.1496
T-stat for Pilot*Year 1
0.0252
1.1111

39

P25

Median

P75

-0.0306
-0.6982

0.0001
0.0032

0.0307
0.6916

-0.049
-0.6675

0.0012
0.0163

0.0513
0.7237

-0.0479
-0.6918

-0.0001
-0.0020

0.0491
0.6936

-0.0361
-0.7160

-0.0006
-0.011

0.0353
0.6764

-0.0555
-0.7193

0.0012
0.0172

0.0552
0.7171

-0.0551
-0.7125

-0.0002
-0.0021

0.0554
0.6956

-0.0577
-0.6959

0.0039
0.0459

0.0617
0.7631

-0.1144
-0.6948

0.0111
0.0726

0.1241
0.8444

-0.9697
-0.7000

0.0052
0.0368

0.1052
0.7721

Panel C. Including the Repeal Period of Regulation SHO Pilot Program


Whole sample
(1)

(2)

(3)

0.074
(0.112)

0.151
(0.148)

0.049
(0.146)

Loan Characteristics
Firm Characteristics
Loan Purpose
Loan type
Year FE
Firm FE

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Yes
Yes
Yes
Yes
Yes
Yes

Observations
Number of Firms
Adjusted R-squared

435
133
0.615

303
90
0.666

132
43
0.543

Pilot*Post

40

With Credit Rating Without Credit Rating

Table 7. DiD Tests on Non-Price Terms


This table shows Regulation SHO Pilot program's effect on non-price facility level loan terms (maturity, use of collateral and amount) and deal level terms
(number of covenants and covenant cushion). Column (7) and (8) are ordered probit regressions and the rest columns are OLS regressions. Debt/EBITDA
Covenant Cushion is percentage difference between firms actual Debt/EBITDA ratio and its contractual limit (Denis and Wang, 2014). Facility -level
controls (maturity, collateral, performance pricing and amount) are included in Column (1)-(6) and deal level controls (whether the deal has a term loan,
number of tranches, whether the deal is secured and deal amount) are included in Column (7)-(10). The sample is drawn from non-financial, non-utility
firms from June 2004 Russell 3000 Index and requires a firm to have loans origination before the approval of SHO Pilot program (June 2004) and after the
implementation (May 2005). Firms are also required to be listed on NYSE, AMEX or NASDAQ through 2002 to 2007, have non-missing loan contract
information in Dealscan and non-missing financial information in Compustat. Loans with primary purpose of Debtor-in-possession, share repurchase and
LBO are excluded. Continuous dependent variables are winsorized at 5th percentile. Standard errors clustered by firm are in parentheses. ***, **, * indicate
significance at the 1%, 5% and 10% levels using two-tailed tests.
Ln(Maturity)
(1)
Pilot*During

(2)

0.028
(0.039)

(3)

Pilot* Year1
Pilot*Year-1

(4)

(5)

0.012
(0.037)
0.034
(0.079)
0.034
(0.067)
0.009
(0.071)

Pilot* Year2

Ln(Facility
amount/Assets)

Collateral

(6)

0.038
(0.071)
-0.003
(0.073)
0.047
(0.053)
0.026
(0.056)

Observations
Adjusted/Pseudo R-Squared
Number of Firms

-0.024
(0.126)
0.085
(0.110)
0.012
(0.111)

Yes
Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
Yes
No

-0.006
(0.115)
Yes
Yes
Yes
No
Yes
No
Yes

1,621
0.645
410

1,621
0.645
410

1,621
0.113
410

1,621
0.113
410

1,621
0.200
410

1,621
0.200
410

1,182
0.074
410

41

(7)

(8)

0.024
(0.134)

Pilot
Firm Controls
Loan Controls/Deal Controls
Loan Purpose/Deal Purpose
Loan type
Year FE
Firm FE
Industry FE

Number of Financial
Covenants

Debt/EBITDA Covenant
Cushion
(9)

(10)

-0.007
(0.027)
0.119
(0.222)
0.219
(0.195)
0.236
(0.194)
-0.161
(0.171)
Yes
Yes
Yes
No
Yes
No
Yes

-0.021
(0.049)
-0.029
(0.041)
-0.027
(0.047)

Yes
Yes
Yes
No
Yes
Yes
No

Yes
Yes
Yes
No
Yes
Yes
No

1,182
0.074
410

357
0.623
146

357
0.622
146

Table 8. Subsamples on Firms Staying with Incumbent Banks after Regulation SHO
This table shows changes in loan terms around Regulation SHO for a subsample of firms that stayed with
the incumbent bank after Regulation SHO. Column (1)-(3) and Column (5) are OLS regression with firm
fixed effects. Column (4) is ordered probit model with one-digit SIC industry fixed effects. Standard
errors clustered by firm are reported in parentheses. Dependent variables are winsorized at 5th percentile.
Standard errors clustered by firm are in parentheses. ***, **, * indicate significance at the 1%, 5% and 10%
levels using two-tailed tests.

Number of Debt/EBITDA
Ln(Facility
Financial
Covenant
Ln(Spread) Ln(Maturity) Collateral Amount/Assets) Covenants
Cushion
(1)

(2)

(3)

(4)

(5)

(6)

-0.096*
(0.054)

1.078
(2.042)

0.002
(0.039)

0.046
(0.096)

-0.006
(0.200)

0.011
(0.037)

Deal/Loan Controls
Firm controls
Deal/Loan Purpose
Year FE
Firm FE
Industry FE

Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
Yes
No

Yes
Yes
Yes
Yes
No
Yes

Yes
Yes
Yes
Yes
Yes
No

Observations
Number of Firms

740
203

740
203

740
203

740
203

561
203

190
79

0.583

0.577

0.068

0.253

0.090

0.620

Pilot*During

Adjusted/Pseudo Rsquared

42

Figure 1.
Dynamics of Loan Spreads around Regulation SHO: This figure shows dynamics of loan spreads of Pilot
and control firms around Regulation SHO Pilot program. Year -1,-2 stands for 1 year and 2 years before
Pilot Program Approval (June 2004) and Year +1, +2 stands for 1 year, 2 years after Pilot program
implementation (May 2005). Year 0 is the gap year between Pilot program approval and implementation.
The approval date of Pilot program (June 23, 2004) is one month ahead of public announcement (July 28,
2004).

43